MARKET COMMENT
The Reality Of Small-Cap Returns

By Maynard Paton (TMFMayn)
April 6, 2004

The last twelve months have witnessed many smaller companies register stellar share price rises. But investors should not get too dazzled by the possible profits available from small-caps. In reality, these shares have significant trading limitations.

This table summarises the ten best performers over the past year:

(* suspended)

This time last year, the ten subsequent big winners were all sporting market values of £10m or below. However, look at their current Normal Market Size (NMS), which is the maximum number of shares in a company that a market maker is obliged to deal in at the quoted price.

Even now, buying sizeable amounts of stock in these companies would appear difficult. After Trafficmaster's £18,000, the largest 'guaranteed' trade value of the ten in today's market is just £3,275. Investors wanting to have traded these shares in larger chunks last year thus had to catch their broker and the market makers on a good day, otherwise they could well have faced a much poorer price. 

Alternatively, buyers could have traded in smaller blocks, which of course would have resulted in more commission and a greater chance of the price going up before the full sum had been invested. It's fair to say that back in the depths of the bear market, the general lack of liquidity meant sizeable small-cap deals were all but impossible.

Spreads would have also harmed the returns. Excluding the suspended Overnet Data, the smallest three of the ten presently have spreads of 8%, 15% and 15%. Note, though, that these three have market values of at least £10m. The spreads in April 2003 for all ten sub-£10m penny share companies would have been even more horrendous.

All in all, it's difficult to believe people buying these shares at the lows got anywhere close to the reported mid-price performances. Nor is it reasonable to assume their gains made them seriously rich.